DiagnoCure, Initiating Coverage at Outperform - Analyst Blog

We are initiating coverage of DiagnoCure Inc. (
T.CUR
,
CUR.TO
) with an
Outperform
rating and $2.25 per share price target. Below are excerpts
from our 20-page initiation report on the company.

BUSINESS

DiagnoCure Inc. (CUR.TO)
is a Quebec, Canada-based developer of molecular diagnostic tests
for the detection and quantification of various forms of cancer,
including colorectal, prostate, lung and bladder. The company
was founded in 1994 and commercialized its first test, for bladder
cancer, in Europe in 1998 and in 2000 the test received FDA
approval. In 2003 they brought an analyte specific reagent (
ASR
) prostate cancer test to the U.S. market which used their
proprietary PCA3 marker. The company is looking to capitalize
on the rapidly growing demand for more accurate and quantifiable
cancer tests - which is being driven by molecular diagnostics, a
segment experiencing 15%+ annual
growth.

The company's current focus is on prostate and colorectal cancer
and includes its flagship PCA3 test (Gen-Probe's Progensa PCA3),
for prostate cancer. The test was approved in Europe in 2006
but had only been available in the U.S. in ASR format until
receiving FDA approval in mid-February 2012. FDA approval
allows commercialization partner Gen-Probe to explicitly market
Progensa PCA3 which could greatly expand its use. The test,
which uses the proprietary biomarker PCA3, could provide
significantly greater clinical utility than the standard prostate
cancer test (i.e. - PSA). PSA is infamously unreliable and,
coupled with a huge unmet demand for a better prostate cancer test,
provides a potentially attractive opportunity for DiagnoCure.
The FDA approved indication (supported by clinical trial data) is
to assess the risk of a future positive biopsy (i.e. - risk of
diagnosing cancer in the future) following a prior negative biopsy
- a worldwide market estimated at about $180MM (DiagnoCure receives
royalties on sales). We believe Progensa PCA3 may also have
utility outside of its indicated use including potentially prior to
an initial biopsy, which would greatly expand the market
opportunity for the test.

The company's colorectal cancer test, Previstage GCC, uses the
marker Guanylyl Cyclase C (GUCY2C or more commonly, GCC) to
stratify the risk of colon cancer recurrence by more accurately
determining the stage of the disease, which is considered the best
determinant of predicting cancer recurrence and survival. As
staging is used to determine the most appropriate course of
treatment, mis-diagnosis can result in compromised patient care and
outcomes. DiagnoCure, which had been selling Previstage GCC
through its own sales force until June 2011, expects uptake of the
test to accelerate as a result of a recent out-licensing agreement
and a regular flow of peer-reviewed publications supporting the
utility of the test. The target market are the ~70k patients
in North America that have been diagnosed by traditional methods as
having Stage I or II colorectal cancer but may actually have more
advanced progression of the disease. DiagnoCure estimates
this market represents ~ $200MM in sales (of which DiagnoCure would
receive royalties on).

In the year 2003 DiagnoCure licensed development and
commercialization rights to their PCA3 marker to Gen-Probe, which
sells their current (and will sell their follow-on test) Progensa
PCA3 tests. In return DiagnoCure received an upfront payment
and continues to receive sales royalties. DiagnoCure had been
selling their Previstage GCC test themselves but in mid-2011 they
restructured operations, selling their CLIA-certified lab and
granting worldwide rights to the Previstage test to Signal
Genetics. DiagnoCure received upfront cash and will receive
ongoing sales royalties as well as some R&D funding. The
move was driven by DiagnoCure's desire to more rapidly expand
growth of the GCC test via a partner with greater distribution
reach, reduce operating expenses and to restock their cash balance,
providing more opportunity to advance pipeline projects.
DiagnoCure had previously mothballed their lung cancer program but
now with additional financial flexibility and funding afforded by
the Signal Genetics deal, the company announced that it will resume
the program which is expected to include the development of a
multiplex PCR-based test.

DiagnoCure's future now largely hinges on execution by their
commercialization partners and their ability to capture as much of
the target markets of each of these two cancer tests. The
recent Signal Genetics deal provides the company with much greater
selling resources and reach. While Previstage GCC has had
only limited success to date, it's possible with Signal Genetics
now onboard that sales could start to show more substantial growth
in the U.S. Similarly, Gen-Probe has not had much success in
moving the needle on Progensa sales in Europe but FDA approval of
the test offers a new opportunity to spark revenue growth.
U.S. regulatory approval now opens up the door to explicitly market
the test with a potentially compelling message to a wide audience -
including directly to the patient which could help uptake in the
absence of widespread insurance reimbursement. The rate of
ramp in sales of the test may be determined by a number of things,
many of which are out of the company's control including coverage
decisions by private payers and the utility of the test in clinical
practice. Perhaps the most influential factor that may shape
the near and intermediate term success of PCA3, however, will be
the level of effort and resources that Gen-Probe dedicates to
marketing and sales of the test.

PCA3 Commercialization Strategy…
The test has been available in the use in ASR format in about 13
laboratories in the U.S. (including Quest, Lab Corp of America, and
Bostwick) and fully commercialized in over 40 labs in Europe.
It is just beginning roll-out in Canada. FDA approval now
opens up the door to explicitly market the test with a potentially
compelling message to a wide audience - including directly to the
patient which could help uptake in the absence of widespread
insurance reimbursement. The rate of ramp in sales of the
test may be determined by a number of things, many of which are out
of the company's control including coverage decisions by private
payers and the utility of the test in clinical practice - which are
both closely related. Despite FDA approval and coverage under
existing CPT codes, more robust reimbursement for the test may be a
progressive process related to evidence from clinical practice that
it can actually improve patient care and/or reduce unnecessary
procedures and the related costs - which may take some time.
One positive factor is that healthcare reform measures have put
greater focus on more rapid adoption and reimbursement of tests
that can save money and improve patient care - which could
potentially bode well for even more favorable reimbursement of
Progensa PCA3. FDA approval will also hopefully facilitate
more widespread reimbursement throughout Europe (which is a
country-by-country decision), lack of which has hampered sales of
the test (the test launched in Europe in late 2006). Perhaps
the most influential factor that may shape the near and
intermediate term success of PCA3, however, will be the level of
effort and resources that Gen-Probe dedicates to marketing and
sales of the test. A dedicated marketing effort will be key
to maximize potential sales of the
test.

Gen-Probe currently sells the test in North America and Europe and
is expected to eventually be run on Gen-Probe's fully-automated
PANTHER system, a next-generation instrument complementing their
older TIGRIS system. PANTHER was CE Marked in late 2010 and
received Health Canada approval in August 2011 - it is already
available in Europe and Canada. Gen-Probe filed for 510(k)
approval of PANTHER in May 2011 - approval is expected to come in
the first half of 2012.

The recently approved FDA indication for Progensa PCA3 is "for use
in conjunction with other patient information to aid in the
decision for repeat biopsy in men 50 years or older who have had
one or more previous negative prostate biopsies and for whom a
repeat biopsy would be recommended by a urologist based on standard
of care". It is contra-indicated for men with atypical small
acinar proliferation (ASAP). As a negative Progensa PCA3
result is associated with a lower chance of a positive biopsy, the
expected value-added by using the test is to reduce the number of
unnecessary repeat biopsies.

There are approximately 1 million prostate biopsies done every year
in the U.S. and a similar number done in Europe. Worldwide,
about 3 million prostate biopsies are done every year. As
roughly 70% of prostate biopsies are negative for cancer, based on
the indicated use of the test, this means the maximum combined U.S.
and European markets are roughly 1.5 million people. While we
note that not all patients with initial negative biopsies will be
recommended for a repeat biopsy and ASAP is present in about 5% of
biopsies - both of which mean that the indicated target markets may
be slightly smaller than 1.5 million, for our financial
model-building and forecasting purposes we think 1.5 million is a
fair gauge of the indicated target market (U.S. and Europe
combined).

Based on $100/test, this represent a total indicated U.S./European
(i.e. - where the test is currently available) market size of
approximately $150 million. Per terms of the development and
commercialization agreement with Gen-Probe, DiagnoCure will receive
royalties equal to 8% of worldwide sales of the PCA3 test up to the
first (cumulative) $62.5MM in sales and 16% royalties beyond
$62.5MM (cumulative). Approximately $27MM in sales have been
generated to date (i.e. - ~ 1/2 to the $62.5MM mark when royalties
of 16% kick in).

Based on an assumed $150 million total market (not including
off-label use), this represents potential peak royalties to
DiagnoCure of $24 million - more realistic peak penetration of the
total market is probably closer to 50% (reached several years after
launch) however, equal to peak royalties to DiagnoCure of $12
million. However, if also used outside of the FDA-approved
indication (i.e. - off-label), especially prior to a first biopsy,
this could potentially expand the market for the test to many
times the size of the indicated market. DiagnoCure believes
the expanded market opportunity for the test is represented by the
9 million people worldwide that are screened with a PSA test and
show elevated PSA (>2.5ng/ml). Progensa PCA3 could
potentially be used to with these individuals to help determine
whether an initial biopsy should be done. Based on a
$100/test, this represents an expanded annual market size of
approximately $900 million. This market is relatively large
and potentially offers significant upside to our model depending on
success of Progensa PCA in penetrating this market segment as we
currently model only very modest sales of the test related to use
prior to first biopsy - we will update our model
accordingly.

Our model assumes the $62.5 million in cumulative sales watermark
(moving the royalty rate to 16%) is attained around mid-to-late
fiscal 2013.

Q4 2011 and 2011 full-year (ending 10/31/2011) royalty revenue from
Gen-Probe were $125k and $605k, approximately flat and up 8%
compared to the year earlier periods, respectively. $605k in
royalties translates to about $7.6 million in PCA3 revenues to
Gen-Probe - which (assuming a total market of $150MM) equals just
over 5% of the target market. Approximately 65% of
Gen-Probe's PCA3 revenue currently comes from Europe - although
with FDA approval, a greater percentage may now shift towards the
U.S.

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